Common Stock

Definition

Common stock represents a type of security that signifies ownership in a corporation. As the most basic form of corporate equity, common stock grants the holder voting rights and a claim on a portion of the company's profits and assets.

5 Must Know Facts For Your Next Test

1. Common stock is the most basic and widely issued type of corporate equity, granting the holder voting rights and a claim on the company's profits and assets.
2. The number of authorized common shares is specified in a company's corporate charter and can be increased or decreased through shareholder approval.
3. Common stockholders have a residual claim on a company's assets and earnings, meaning they are paid out only after all other obligations have been met.
4. The value of common stock is determined by the market and can fluctuate based on factors such as the company's financial performance, industry trends, and investor sentiment.
5. Dividends on common stock are not guaranteed and are typically paid at the discretion of the company's board of directors, unlike the fixed dividends of preferred stock.

Review Questions

• Explain how common stock is represented on the Statement of Owner's Equity and how it impacts a company's capital structure.
  • Common stock is the primary component of a company's shareholders' equity, as reported on the Statement of Owner's Equity. The number of common shares outstanding and their par value are listed, along with any additional paid-in capital from the issuance of new shares. The balance of common stock on the statement reflects the ownership claims of the company's common shareholders. In terms of capital structure, common stock represents the residual equity claim, after all other obligations have been met, and is considered the riskiest but potentially most rewarding component of a company's financing mix.
• Describe the key differences between common stock and preferred stock, and how these differences impact a company's capital structure decisions.
  • The primary differences between common stock and preferred stock are that preferred stock typically has a fixed dividend payment, a higher claim on assets and earnings than common stock, and potentially limited or no voting rights. These differences mean that preferred stock is generally viewed as less risky than common stock, but also offers lower potential returns. From a capital structure perspective, the inclusion of preferred stock can provide a company with a more stable source of financing than relying solely on common stock, which can be more volatile. However, the use of preferred stock also means a company has a higher fixed cost of capital compared to an all-common stock capital structure.
• Analyze how a company's decision to issue additional common stock, either through a public offering or private placement, would impact its capital structure and the claims of existing common shareholders.
  • The issuance of additional common stock, whether through a public offering or private placement, would increase the total number of common shares outstanding and dilute the ownership claims of existing common shareholders. This would reduce the proportional ownership and voting rights of current common stockholders, as well as potentially impact the per-share value of the company's earnings and dividends. From a capital structure perspective, the injection of new common equity capital would decrease the company's debt-to-equity ratio, potentially improving its financial leverage and risk profile. However, the increased number of shares outstanding could also make the company's stock more volatile and less attractive to some investors, depending on their investment objectives and risk preferences.

Related terms

Preferred Stock:

Preferred stock is a type of equity security that provides the holder with a fixed dividend, higher claim on assets and earnings than common stock, and potentially limited or no voting rights.

Authorized Shares: Authorized shares refer to the maximum number of shares a company is legally permitted to issue, as specified in its corporate charter.

Dividend:

A dividend is a distribution of a portion of a company's earnings, decided and paid out to a class of its shareholders.